Garbage Gauge Pointing Up for Trash Stocks

Waste Management and Republic Services form a virtual duopoly over the U.S. trash business

The green movement has caused recycling to take on increased importance for garbage companies

D'Arcy Norman

Landfill

Want a quick read on the economy? Just sift through the dumpster behind your favorite restaurant. When consumers abandon fast food for more upscale options, food waste increases while paper waste from burger wrappers and fries levels out.

The latest garbage gaugeis pointing to a slow but steady recovery that should see trash volumes turn positive this quarter or next for the first time since 2008.

That should propel profits of trash haulers who’ve been able to maintain pricing power through the recession thanks to long-term, customer-specific contracts.

“We like the solid waste companies at this point in the economic cycle,’’ says Wedbush Securities analyst Al Kaschalk, referring to the operators of the front-end loader trucks that collect garbage generated by homes, strip malls and office towers. He likes this broader sector of waste management over the specialty firms that dispose of medical and industrial waste. More on those stocks later.

Trash Inc: The Secret Life of Garbage

You can gain solid waste exposure through Waste Management and Republic Services. The two companies form a virtual duopoly over the U.S. trash business that should increase as more cash-strapped municipalities exit the business and M&A activity continues.

Republic is more dependent on core trash collection (77 percent of revenues) than Waste Management (57 percent of revenues) and should see more of a profit kick from servicing growing garbage volumes. The company has outperformed the market this year through operating efficiencies and cost savings from its $6 billion acquisition of Allied Waste.

Kaschalk expects Republic to grow earnings per share by 13 percent this year and 17 percent in 2011, figures sure to rise should volume come back stronger than projected. Easier year-over-year comparisons, the likelihood of dividend increases and a share buyback program, expected to be announced before year end, should also boost profits. Kaschalk rates Republic a buy and sees the shares rising to $38 over the next year.

Another Wall Street favorite is IESI-BFC. The Toronto-based company better known as BFI is less exposed than its competitors to index-based pricing contracts required by some municipalities—which can be a drag in a deflationary environment—and has gained market share and cost savings from its 2010 purchase of Waste Services.

BIN shares are up more than 80 percent in the last year, which may raise a red flag for some investors. Analysts, however, see the momentum continuing. “BIN has a lot more opportunity,’’ says Wunderlich Securities analyst Michael Hoffman, pointing to growth prospects in the New York-Canada, Texas-Louisiana, and Florida regions that could push the stock to $27 in the next year.

Waste Connections sports the highest profit margins in the industry due to exclusive long-term contracts and a concentration in less populated markets where it can charge higher prices. The mid cap company also has a strong balance sheet to drive future growth through acquisitions. Wedbush’s Kaschalk sees the stock moving to $42 over the next 12 months.

Jim Franco | Digital Vision | Getty Images

The green movement has caused recycling to take on increased importance for waste management companies. No firm has embraced the trend more than Casella Waste Systems, which has invested nearly $180 million in recycling infrastructure.

Casella has been plagued by high debt levels, but asset sales and a new CFO with experience restructuring balance sheets should help.

Most small cap garbage stocks trade at one times annual revenues or better. But Casella shares are currently valued at less than a quarter of its $554 million in annual sales, leaving plenty of room to run should its debt levels drop and recycling volumes pick up.

Investors can get industry wide exposure to the trash business through the Global Market Vector’s Environmental Services ETF . Four stocks account for nearly 40 percent of the fund, led by top holdings Waste Management and medical waste specialist Stericycle. Another exchange traded fund, the Global X Waste ManagementETF, has filed its registration statement but is not yet available to investors.

EVX TOP HOLDINGS: A TRASHY ETF

Waste Management

WM

Stericycle

SRCL

Veolia Environment

VE

Republic Services

RSG

Newpark Resources

NR

Nalco Holding

NLC

IESI-BFC

BIN

Waste Connections

WCN

Darling International

DAR

Layne Christensen

LAYN

Stericycle in medical and Clean Harbors in industrial are the largest of the specialty waste managers that are more dependent on industry-specific factors than general economic cycles.

Stericycle, which disposes of needles and medical waste, is adept at upselling existing customers and is a leader in the burgeoning pharmaceutical waste market. A small but growing presence overseas should also drive profits higher, says Jefferies analyst Richard Close, who sees the stock hitting $80 within a year.

Clean Harbors, a manager of hazardous and chemical waste disposal and recycling, is one of the more attractively priced stocks in the sector, with a PEG ratio (P/E divided by expected earnings growth rate) of just 0.77, compared to 6.58 for BIN and 1.7 for Stericycle. It has a major role in the ongoing Gulf oil spill cleanup efforts and should see increased revenues from a pickup in industrial activity.

Greater economic activity could portend the return of inflation. Couple that with volumes supported by population growth and an eventual return of commercial and residential construction—a major market the industry’s been missing for almost two years—and Wunderlich’s Hoffman says the garbage industry should be able to “sustain 2-3 percent pricing [premiums] for as far as you can see.”

On Wednesday, September 29 at 9pm ET/PT, CNBC presents “Trash Inc: The Secret Life of Garbage,”a CNBC Original reported by Carl Quintanilla that takes an inside look at what happens to our garbage after we throw it out – where it goes, who touches it, and who makes money.